John Bogle

In my last post, I mentioned John Bogle's study. I have not yet read of much of his work. He does have a website, but what I am trying to find is the original study that he did comparing the Fund's Return to the average investor's return.

Most Fund's measure their historical performance since inception or over set periods (say 1, 3, 5 ,10 years). The measure used most often is the Time-Weighted Rate of Return (TWR) since this is not impacted by the cash flows into and out of the fund. It is a clean measure of what $1 invested in the fund would grow to over the period measure. The actual return (Internal Rate of Return  or IRR) is affected by cash flows. 

If you invest $1 and it grows to $5 in 6 months, so you get excited... who wouldn't be with 400% growth, and top your investment up to $100 ($95 more), then there is a 50% drop in the next 6 months.

Your Net Investment = $96

TWR = 150%

IRR = -72.6%

Clearly the fund manager has no control over when you choose to invest or disinvest. The problem comes in if you regularly choose to invest just after the fund has done really well and sell just after it has done badly.

So in this example, the TWR of 150% shows a very successful year for the fund, but the client has lost a lot.

This is a very short term and extreme example, but over time if the client is very active in entering and leaving the fund... there is no reason why their return should be the same as the funds.